Tag: guaranteed minimum withdrawal benefit

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Annuities Deferred Income Annuities Fixed Index Annuities Retirement Income Planning

Sustainable Lifetime Income When You Need It – Part 2 of 2

Part 1 of this post made the point that if your goal is to receive sustainable lifetime income, in addition to Social Security, fixed income annuities offered by life insurance companies will meet your need. Please read Part 1 to learn about the three types of fixed income annuities, including each one’s income start date.

If you’re seeking total flexibility for your lifetime income start date, then a fixed index annuity (“FIA”) with an optional income rider is your best bet. Unlike single premium immediate annuities (“SPIA’s”) and deferred income annuities (“DIA’s”) where the sole purpose is to provide sustainable income, a FIA can fulfill multiple financial needs, a discussion of which is beyond the scope of this post. When you purchase a FIA, assuming your goal is sustainable lifetime income, you must purchase an optional income rider with an annual income rider fee.

Unlike the start date for SPIA’s and DIA’s which is contractually defined, it is much more flexible with FIA’s. Most FIA income riders, also known as guaranteed minimum withdrawal benefit (“GMWB”) riders, have two requirements when it comes to the income start date:

  1. You must wait at least one year after the contract is issued, and
  2. You must be at least age 50.

Assuming that you meet both requirements, the age at which you begin taking income withdrawals from a FIA is up to you. Unlike Social Security which has an eight-year window for choosing your income start date, i.e., between age 62 and 70, the start date with FIA’s is open-ended once the two requirements have been met.

Similar to Social Security, the longer you defer your start date, the greater your lifetime income payments will be. Unlike Social Security where your benefit amount will increase 7% – 8% each year that you defer your start date, the amount of increase is defined by the income rider provision of each FIA’s contract. Also, unlike Social Security, the percentage increase is generally significantly greater when you cross five-year milestones, e.g., age 60, 65, 70, 75, etc.

Here’s an example from a recent case for one of my clients who are currently in their early to mid 50’s and have invested approximately $250,000 in a FIA with an income rider. If they begin taking income at the younger spouse’s age 63, they will receive annual lifetime income of $20,479. At age 64, the amount increases 6% to $21,708. If they wait until age 65, it increases 19.3% from their age 64 amount to $25,886.

With a FIA with an income rider, in addition to having the security of receiving sustainable lifetime income, you have the luxury of starting your income when you need it. This is in addition to several other benefits offered by FIA’s, a discussion of which has been presented in various Retirement Income Visions™ posts.

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Fixed Index Annuities Retirement Income Planning

Cap Rates Are Secondary When Optimizing Retirement Income

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If you’ve been reading Retirement Income Visions™ for any length of time, you know that I’m a fan of fixed index annuities (“FIA’s”) with income riders, or guaranteed minimum withdrawal benefit’s (“GMWB’s”) as part of a retirement income planning solution in the right situation. The ability to create a predictable retirement paycheck with a flexible start date that includes an investment component with upside potential, downside protection, and a potential death benefit is unparalleled in the investment and insurance world.

For you horse race fans, that’s what I call hitting the trifecta! Unlike horse race betting, when you invest in a FIA with an income rider with a highly-rated life insurance company, while the results aren’t guaranteed since they’re subject to the claims paying ability of each individual insurance carrier, your bet is pretty secure given the stellar historical claims paying experience of the life insurance industry.

It’s important to understand that very few FIA’s that are sold today include GMWB’s as part of their base product. If you need sustainable lifetime income beginning at a specific age, you will generally need to purchase an optional income rider when you complete your FIA application. Only about two-thirds of FIA’s on the market today offer an optional income rider. An income rider charge of between 0.75% and 0.95% of your contract’s income account value will generally be deducted from your contract’s accumulation value each year.

Assuming that your goal is to maximize sustainable lifetime income, once you, or more likely your retirement income planner, narrows your FIA search to those that include a GMWB or optional income rider, illustrations need to be prepared for multiple products offered by highly-rated life insurance companies that are well-established in the FIA business to determine which ones will provide you with the greatest amount of income for your desired investment amount(s) beginning at various ages.

This is a difficult task due to the fact that there are several variables that are used in the calculation of annual income that will be received from a particular FIA. After analyzing hundreds of FIA illustrations, trust me, it requires a lot of skill, hands-on experience, and access to dozens of options, including appointment as a licensed life insurance agent with multiple life insurance carriers, in order to offer an independent optimal recommendation for a particular situation. One product may provide greater income beginning at age 62, however, another one may be more suitable if you don’t plan on taking withdrawals until age 70.

What about cap rates? Assuming your goal isn’t to create a predictable retirement paycheck, there’s no need to purchase a FIA with a GMWB or income rider. If this is your situation, you should be paying close attention to the caps, or limits, on interest that will be credited to your account each year that are associated with various indexing methods offered by a particular FIA depending upon its performance during the previous contract year.

If, on the other hand, your primary goal is to optimize lifetime income beginning at a particular age, cap rates, while important, should be a secondary consideration when choosing a FIA. While higher cap rates may result in a greater accumulation value that may more seamlessly absorb income rider charges associated with good market performance and may potentially result in a greater death benefit, they generally won’t affect the amount of lifetime income that you will ultimately receive from a particular FIA. This is due to the fact that the lifetime income calculation of most FIA’s is generally independent of indexing method performance. Furthermore, even if there’s no remaining accumulation value in your contract as a result of income withdrawals over many years, you will continue to receive your income so long as you’re alive.

While cap rates are often hyped by life insurance companies when promoting FIA’s, they should be a secondary consideration when your primary goal is to create and optimize a predictable retirement paycheck beginning at a specific age. If this is your situation, you or your retirement income planner should be devoting the majority of your research to locating those FIA’s offered by highly-rated life insurance companies that are well-established in the FIA business that include a GMWB or income rider that will enable you to achieve your goal.

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Annuities Deferred Income Annuities Fixed Index Annuities

Invest in DIA to Fund LTCI Premiums When Retired – Part 4 of 4

The first three posts in this series discussed five differences between fixed index annuities (“FIA’s”) with income riders and deferred income annuities (“DIA’s”) that will influence which retirement income planning strategy is preferable for funding long-term care insurance (“LTCI”) premiums in a given situation. If you haven’t done so already, I would recommend that you read each of these posts.

This week’s post presents a sample case to illustrate the use of a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement.

Assumptions

As with all financial illustrations, assumptions are key. A change in any single assumption will affect the results. The following is a list of assumptions used in the sample case:

  1. 55-year old, single individual
  2. Planned retirement start age of 68
  3. Life expectancy to age 90
  4. Current annual LTCI premium of $4,000 payable for life
  5. Need to plan for infrequent, although potentially double-digit percentage increases in LTCI premium at unknown points in time
  6. Given assumptions #4 and #5, plan for annual pre-tax income withdrawals of approximately $6,000 beginning at retirement age
  7. Solve for single lump sum investment at age 55 that will provide needed income
  8. Investment will come from a nonqualified, i.e., nonretirement, investment account
  9. One investment option is a fixed index annuity (“FIA”) with an income rider with lifetime income withdrawals beginning at age 68.
  10. Second investment option is a deferred income annuity (“DIA”) with no death benefit and lifetime income payout beginning at age 68.
  11. FIA premium bonus of 10%
  12. FIA annual return of 3%
  13. FIA income rider charge of 0.95% of income rider value otherwise known as the guaranteed minimum withdrawal benefit (“GMWB”)
  14. No withdrawals are taken from the FIA other than the income withdrawals.
  15. All investments are purchased from highly-rated life insurance companies known for providing innovative and competitive retirement income planning solutions.

Investment Amount

The first thing that needs to be solved for is the amount of investment that must be made at the individual’s age 55 in order to produce lifetime annual income of approximately $6,000 beginning at age 68. The goal is to minimize the amount of funds needed for the investment while choosing a strategy from a highly-rated insurance company that’s known for providing innovative and competitive retirement income planning solutions.

It turns out that an investment of $50,000 to $65,000 is needed to produce lifetime annual income of approximately $6,000 beginning at age 68. Given the fact that my goal as a retirement income planner is to use the smallest amount of investment for a fixed income annuity to produce a targeted income stream in order to preserve the remainder of a client’s investment portfolio for my client’s other financial goals, the amount of the investment needed is $50,000.

Results

There are three items we will examine to compare the results between investing $50,000 in a FIA with an income rider vs. a DIA to fund LTCI premiums during retirement. They are as follows:

  • Annual gross income
  • Annual taxable income
  • Value/death benefit

Annual Gross Income

Per the Exhibit, the annual payout, or gross income, from the FIA is $5,764, or $236 less than the annual gross income of $6,000 from the DIA. This equates to a total of $5,428 for the 23 years of payouts from age 68 through age 90.

Annual Taxable Income

If the investment was made in a retirement account like a traditional IRA and assuming there have been no nondeductible contributions made to the IRA, 100% of the income would be taxable. This would be the case for both the FIA or DIA.

As stated in assumption #8, the investment will come from a nonqualified, i.e., nonretirement, investment account. Per Part 2 of this series, this makes a difference when it comes to taxation of the withdrawals. Per the Exhibit, 100% of the annual FIA income of $5,764 is fully taxable vs. $3,066 of the DIA income. This is because the DIA, unlike the FIA, is being annuitized and approximately 50% of each income payment is nontaxable as a return of principal. Over the course of 23 years of payouts, this results in $62,054 of additional taxable income for the FIA vs. the DIA.

The amount of income tax liability resulting from the additional taxable income from the FIA will be dependent upon several factors that will vary each year, including (a) types, and amounts, of other income, (b) amount of Social Security income, (c) potential losses, (d) adjusted gross income, (e) itemized deductions, (f) marginal tax bracket, and (g) applicable state income tax law.

Value/Death Benefit

While the present value of the future income stream of a DIA represents an asset, you generally won’t receive an annual statement from the life insurance company showing you the value of your investment. In addition, while some DIA’s will pay a death benefit in the event that the annuitant dies prior to receiving income, per assumption #10, this isn’t the case in this situation. Consequently, the DIA column of the “Value/Death Benefit” section of the Exhibit is $0 for each year of the analysis.

On the other hand, there’s a projected value for the FIA from age 55 through age 79. This value is also the amount that would be paid to the FIA’s beneficiaries in the event of death. There’s a projected increase in value each year during the accumulation stage between age 55 and 67 equal to the net difference between the assumed annual return of 3% and the income rider charge of 0.95% of the income rider value.

Per the Exhibit, the projected value/death benefit increases from $56,278 at age 55 to $68,510 at age 67. Although the assumed premium bonus of 10% is on the high side these days, this is reasonable given the fact that FIA values never decrease as a result of negative performance of underlying indexes, the assumed rate of return of 3% is reasonable in today’s low index cap rate environment, and the assumed income rider charge of 0.95% of the income rider value is on the upper end of what’s prevalent in the industry. The projected value/death benefit decreases each year from age 68 to age 79 until it reaches $0 beginning at age 80 as a result of the annual income withdrawals of $5,764.

Conclusion

As discussed in Parts 1 – 3 of this series, there are five important differences between FIA’s with income riders and DIA’s that will influence which retirement income planning strategy is preferable for funding LTCI premiums during retirement in a given situation. Two of the differences, income start date flexibility and income increase provision, haven’t been addressed in this post.

In addition to the five differences, the amount of the investment required to produce a targeted lifetime annual income amount to pay LTCI premiums, including potential increases, will differ depending upon the particular FIA or DIA strategy used. In the illustrated case, which isn’t uncommon today, an investment of $50,000 resulted in an almost identical lifetime income payout whether a FIA with an income rider or a DIA is used.

As illustrated, the taxable income associated with a DIA in a nonqualified environment is much less compared to a FIA. As previously discussed, the amount of tax savings resulting from the reduced taxable income will depend upon an analysis of several factors and will vary each year. Ignoring the potential income tax savings resulting from the tax-favored DIA payouts, the FIA with income rider would be the preferred investment choice for many individuals in this case given the presence, duration, and projected amount of, the investment value/death benefit.

The FIA edge is reinforced by the fact that, unlike most traditional DIA’s, the income start date and associated annual lifetime income payout amount for FIA’s is flexible. This would be an important consideration in the event that the year of retirement changes. Furthermore, this is quite possible given the fact that the individual is 13 years away from her projected retirement year.

As emphasized throughout this series, the purchase of LTCI needs to be a lifetime commitment. Planning for the potential purchase of a LTCI policy should be included as part of the retirement income planning process to determine the sources of income that will be used to pay for LTCI throughout retirement. Whether it’s a FIA with an income rider, a DIA, or some other planning strategy that’s used for this purpose will depend on the particular situation.

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Annuities Deferred Income Annuities Fixed Index Annuities

FIAs With Income Riders vs. DIAs: Which is Right for You? – Part 2 of 5

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As stated in Part 1 of this post, while fixed index annuities (“FIAs”) with income riders can be used to provide guaranteed (subject to the claims paying ability of individual life insurance companies) lifetime income beginning at a future date, they aren’t the only fixed income annuity game in town. Of the 12 features offered by FIA’s with an income rider that are listed in Part 1, three are offered by deferred income annuities (“DIAs”), four are applicable on a limited basis, and the remaining five aren’t applicable. The last group is the subject of this post.

The following is a list of the five features offered by FIAs that aren’t applicable to DIAs:

  1. Potential doubling of income amount to cover nursing home expense
  2. Investment value in addition to future income stream
  3. Protection from loss of principal
  4. Potential for increase in investment value
  5. Potential matching of percentage of investment amounts by financial institution

Potential Doubling of Income Amount to Cover Nursing Home Expense

The first feature, potential doubling of income amount to cover nursing home expense, isn’t a standard feature of FIAs with income riders. Of the 184 FIAs that currently offer guaranteed minimum withdrawal benefits (“GMWBs”), or income riders, 53, or less than one-third, include some type of long-term care benefit. When present, the amount of the benefit compared to the standard income amount, as well as qualification for this benefit, varies.

Investment Value in Addition to Future Income Stream

While DIAs and FIAs with income riders both offer the ideal retirement income feature of guaranteed (subject to the claims paying ability of individual life insurance companies) tax-deferred lifetime income, only FIAs also have a traditional investment value associated with them. Psychologically, this is comforting to investors who are uneasy with exchanging a lump sum of money “only” for an income stream who don’t understand the concept that the present value of the future income stream is an investment just like a brokerage account or any other investment asset.

Protection From Loss of Principal

Protection from loss of principal as well as features #4 and #5 are driven by feature #3, i.e., investment value in addition to a future income stream. The investment, or accumulation, value of FIAs, as it’s better known, will never decrease as a result of investment performance. It will either increase or remain unchanged on an annual or biennial basis, depending upon particular stock indexing strategies chosen. In the event of negative performance of a particular strategy, it will remain unchanged.

Potential for Increase of Investment Value

The investment, or accumulation, value of a FIA can increase to the extent that it’s allocated to one or more of the following three investment choices:

  1. Fixed account
  2. Traditional indexing method when the performance of the chosen index is positive
  3. Inverse performance trigger when the performance of the associated index is negative

The last choice, inverse performance trigger, isn’t a standard FIA indexing crediting option. Of the 253 FIAs on the market today, there are only 12 products available from two life insurance companies that offer this innovative strategy.

Potential Matching of Percentage of Investment Amount by Investment Institution

As previously stated, unlike DIAs that don’t have a traditional investment value associated with them, FIAs offer this feature. In addition, of the 253 FIAs available today, 130, or approximately one-half, have a percentage matching, or premium bonus, as it’s more commonly known, feature. A premium bonus is a fixed percentage of the investment in a FIA that’s added by some life insurance companies to the FIAs accumulation value during the first contract year and, sometimes, subsequent contract years, for a specified number of years.

As discussed in previous posts, the availability of this feature, as well as the bonus percentage amount when offered, shouldn’t be relied upon in and of itself to determine the suitability of a particular FIA in a given situation.

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Annuities Fixed Index Annuities

When Should You Begin Your Lifetime Retirement Payout? Part 1 of 2

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When you purchase a fixed index annuity (“FIA”) with an income rider, in addition to having an accumulation value that’s standard with every FIA, you purchase the right to receive a future lifetime income stream, or lifetime retirement payments (“LRP’s”). The income stream is payable over your life and potentially that of a spouse or other joint annuitant if applicable.

Although you’re not required to exercise the income rider, it behooves you to do so since there’s generally a cost associated with the rider. The income rider charge is deducted from the contract’s accumulation value. It’s calculated as either a percentage of the accumulation value or the income account value, sometimes referred to as the guaranteed minimum withdrawal benefit, or “GMWB,” with the calculation based on income account value for most riders.

When should you exercise your income rider and begin your lifetime retirement payout? In order to answer this question, you first need to know when your income rider allows you to start taking income withdrawals. Generally speaking, income riders allow you to begin taking income withdrawals either during the initial contract year or after the first contract year. In addition, most contracts won’t let you start withdrawing income until you attain a specific age, typically 50.

Assuming that the provisions of your income rider allow you to begin your income stream during or after the first contract year, should you turn on your LRP right away? Generally speaking, this isn’t a good strategy. Similar to Social Security where you have the right to receive benefits beginning at age 62, unless you have no other source of income, it generally doesn’t make sense to do so.

With both Social Security and FIA income riders, the longer you defer your income start date, the greater your income will be. Unlike Social Security benefits which max out at age 70 excluding cost of living increases, as a general rule, FIA income rider beginning withdrawal amounts continue to increase well beyond age 70.

The LRP increase amount is dependent upon two factors: (1) Number of years remaining in the accumulation phase of the income account value and (2) Age at which withdrawal percentages no longer increase. Once the income account accumulation phase ends, LRP increases will generally occur every five years since the withdrawal percentages of most income riders are based on five-year age bands, e.g. 75 – 79, 80 – 84, etc. The final age band of some income riders is 80+ up to 95-99 for one of the income riders available through my life insurance agency.

Even though the beginning LRP continues to grow until age 80 or beyond, should you wait this long to exercise your income rider? In most situations, the answer is often “no,” however, if you purchased your FIA at an advanced age, say 70 or older, it will generally behoove you to defer your income start date in order to complete your income account value accumulation phase and, in the process, optimize your benefit amount, assuming you’re in good health. As discussed in the April 2, 2012 post, How is Your Fixed Index Annuity’s Income Account Value Calculated?, if income hasn’t been started, the interest period of the accumulation phase is generally a certain number of years, typically ten, although it can be limited by a specified age, e.g., 85 or 90.